Week in review: Anchors aweigh on the good ship QE2

Central bankers were back in the headlines this week. This time it was the European Central Bank’s (ECB) turn to get in on the act. As expected, the Bank took rates further into negative territory, cutting by a modest 10 basis points (bps) to -0.5%. The ECB also said it would restart quantitative easing – the much-trailed QE2 – in November. Asset purchases will tally at €20 billion-a-month. Banks were also cheered after the ECB announced a two-tiered system that would exclude some of the lenders’ excess deposits from negative rates.

But the biggest surprise came in the forward guidance. The Bank said that rates would stay on hold (or go lower) until the inflation outlook converged to a level “sufficiently close to, but below, 2%”. The ECB also said QE2 would continue for “as long as necessary”, with the programme ending shortly before it raises rates. German Bund yields initially dropped 9 bps to -0.65%. However, a slip of the tongue by Draghi during his press conference – where he indicated that expansionary fiscal policy would be a trigger to raise rates – caused yields to end the day at -0.51%.

What does all this mean? By our calculations, it’s highly unlikely that inflation will converge to 2% by end 2021 (our forecast horizon) and perhaps not for a long time after that. Indeed, markets are pricing in inflation averaging 1.3% per annum over the next decade. In other words, the ECB has just made a very open commitment to keeping rates negative and QE running for the foreseeable future. Furthermore, the tiering of rates is the ECB’s way of encouraging core European banks to lend to their peripheral counterparts. In other words, we have supportive measures from the Bank on the one hand; while on the other, it is encouraging fiscal spending. It's therefore fair to ask: are we seeing a form of debt socialisation by the backdoor?

Gone fishin’

After much ballyhoo, Boris-bashing and even a defiant few bars of Calon Lan from the backbenches, the UK’s parliament was finally prorogued on Monday. Its doors will now remain shut for five weeks – the longest prorogue in peacetime. Or will they? For this week, the plot – which was already thicker than yer granny’s porridge – thickened further after the Scottish Court of Session deemed the government’s prorogation “unlawful”. Summing up, the three judges concluded that Boris and co.’s actions were “improper” and a “tactic to frustrate parliament”. Opposition parties immediately called for parliament to be reconvened.

The government, however, was quick to push back. Scottish law, it rightly said, differs from its English equivalent. As such, ministers said they would not act until the UK Supreme Court has ruled on the matter. Will the be-wigged denizens of the highest court in the land also deem the prorogue unlawful? Who can tell. But, given the manic merry-go-round that is the Brexit process, anything is possible. In the meantime, sterling continued on its march upwards, hitting $1.24.

Détente, for now

A little good news goes a long way at the moment. This time, a mild easing of tensions in the ongoing US-China trade dispute lifted global equity markets and cut the legs from bond yields. Behind the moves was Beijing’s decision to exempt 16 US products from its recent round of tariffs. President Trump called it a “big deal”, although high-profile products such as soybeans and pork remained on the naughty list. Nonetheless, in a reciprocal show of “goodwill”, Trump announced that he was pushing back the $250 billion tariffs on Chinese wares for a couple of weeks. Is this the start of something “beautiful”? We doubt it. The underlying issues remain unresolved and, as we’ve seen time and again, we’re only ever one presidential tweet away from the wheels coming off once more (see And Finally…).

A thumb in the PPI

Turn to any channel on British TV of an afternoon and chances are you’ll be wooed by a clean-cut claims manager purring: “have you been mis-sold PPI? Could you be due compensation?” And who can blame them: after all, the payment protection insurance scandal (aka PPI) is BIG business. Indeed, UK banks have now doled out a whopping £50 billion (bn) by way of recompense. The latest round came after Lloyds Banking Group and Barclays revealed additional charges due to a flood of last-minute claimants (£1.8bn for the former, £1.6bn for the latter). However, what’s been bad for the banks has been undoubtedly good for the UK economy. From home improvements to holidays, Britons have spent their booty well. Meanwhile, according to Manpower, dealing with the PPI claims has created around 20,000 jobs. People’s QE in action?

On the markets

Easing trade tensions, ECB action and some better news on the global economy ensured most major indices finished in positive territory. The S&P was up 1% over the week to close of business Thursday, while the FTSE 100 and FTSE Europe (ex-UK) returned 0.9% and 0.8% respectively. But the standout performer was the MSCI Emerging Markets Index, which delivered a heady 1.4%. Encouragingly, IPOs were back with a vengeance after a period in the doldrums. Names coming to market include AB InBev, ESR Cayman and Helios Towers.

Meanwhile, government bond markets were routed. The 10-year US Treasury yield shot up close to 25 bps, 10-year gilt yields increased 20 bps, while German Bund yields rose 15 bps. Meanwhile, the Japanese yen slumped 1.3% on a trade-weighted basis. A traditional safe-haven currency, it behaved as expected during a period where investors were adding risk.

And finally…

President Trump’s love of Twitter is legendary. From his campaigning days to his time in the White House, there’s nary a subject goes by that Trump won’t address in 280 characters or fewer. As a citizen, his electronic musings were a source of entertainment; as President, his online outpourings have the power to move markets. So much so, that JP Morgan Chase & co. has created the ‘Volfefe Index’. Named after one of Trump’s more, erm, esoteric tweets, the index seeks to measure the impact his missives have on bond markets. The answer? A fair bit. According to analysts, of some 4,000 tweets fired out during trading hours over the last 12 months, nearly 150 shifted the market. Particularly potent words include “China”, “billion”, “products” and “great”. Time will tell if “Boneheads” – the word Trump used to describe the Fed this week – eventually makes the list. We wouldn’t be surprised.


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